Whitney Tilson T2 Accredited Fund Annual Letter-2010

The GM Building, 767 Fifth Avenue, 18

th

Floor, New York, NY 10153

Whitney R. Tilson and Glenn H. Tongue phone: 212 386 7160 Managing Partners fax: 240 368 0299www.T2PartnersLLC.com

January 4, 2011Dear Partner,We hope you had wonderful holidays and wish you a happy new year!In each of our annual letters we seek to frankly assess our performance, reiterate our core investmentphilosophy, and share our latest thinking about various matters. In addition, we discuss our 12 largestlong positions so you can better understand how we invest, what we own and why, and why we have somuch confidence in our fund

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s future prospects.Our fund had a solid year, though due to a lethargic last four months we ended the year trailing the S&P500 for only the third time in our 12-year history (all three times, our underperformance was in singledigits):

December 4

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Quarter Full YearTotalSinceInceptionAnnualizedSinceInceptionT2 Accredited Fund - gross 0.3% -4.0% 12.9% 260.8% 11.3%

T2 Accredited Fund - net 0.3% -3. 3% 10.3% 184.9% 9.1%

S&P 500 6.7% 10.8% 15.1% 26.5% 2.0%Dow 5.3% 8.0% 14.1% 65.7% 4.3%NASDAQ 6.3% 12.2% 17.8% 24.8% 1.9%

Past performance is not indicative of future results. Please refer to the disclosure section at the end of this letter. The T2 Accredited Fundwas launched on 1/1/99. Gains and losses among private placements are only reflected in the returns since inception.

This chart shows our performance since inception:

-40-20020406080100120140160180200Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

(%)

T2 Accredited Fund S&P 500

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Overview of 2010

We had four huge winners in 2010, each accounting for more than four percentage points of return (indescending order of contribution): General Growth Properties, our biggest winner for the second year ina row, which emerged from bankruptcy as two companies; Berkshire Hathaway, thanks to our big betearly in the year that the stock would be added to the S&P 500; Liberty Acquisition Corp. warrants,which skyrocketed when the merger with Grupo Prisa was consummated; and BP, in which we correctlyanticipated that the company would weather the Gulf of Mexico crisis.We had no losers of note on the long side

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the biggest was Winn-Dixie, which fell 28.5% and cost us0.6% of performance

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but we took quite a beating on the short side. Among the most costly shorts,each costing us more than 1% of performance, were Netflix, MBIA, DineEquity, and LululemonAthletica. We short both to make money and protect our portfolio from a market downdraft, but in 2010we only succeeded in the latter, as we discuss further below.Our first priority is always capital preservation, so we are usually playing defense, even if this means wesometimes trail the market when it

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s ripping upward. On rare occasions, however, in periods like late2008 and early 2009, the market offers enough opportunities that we can go on offense and practice get-rich-quickly investing. We wish we were in such a period

today, but don’t believe we are

. Instead, weare in a time of

“

unusual uncertainty

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(to quote Ben Bernanke), yet the market is complacent, so wethink it

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s prudent to be quite defensive, both by maintaining a robust short book and also, on the longside, by focusing on big-cap, blue-chip stocks with strong market positions, cash flows and balancesheets.

Performance Objectives

In every year-end letter we repeat our performance objectives, which have been the same since ourfund

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s inception (no changing the rules in the middle of the race): Our primary goal is to earn you acompound annual return of at least 15%, measured over a minimum of a 3-5 year horizon.We arrived at that objective by assuming the overall stock market is likely to compound at 5-10%annually over the foreseeable future, and then adding 5-10 percentage points for the value we seek toadd, which reflects our secondary objective of beating the S&P 500 by 5-10 percentage points annuallyover shorter time periods. While a 15% compounded annual return might not sound very exciting, itwould quadruple your investment over the next 10 years, while 7-8% annually

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about what we expectfrom the overall market

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would only double your money.Since inception 12 years ago, we have not met our 15% objective, thanks in part to one of the worstperiods ever for stocks. We have, however, outperformed the S&P 500 by 7.1 percentage points peryear, near the midpoint of our 5-10 percentage point goal. There are few funds that have beaten themarket by this margin over the past dozen years, but nevertheless we are not satisfied with ourperformance and aim to improve it.

Performance Assessment

In light of our objectives, we

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d give ourselves a B for the year. To understand why we give ourselves agood grade, despite neither earning a 15% return nor beating the market, one must understand how weapproach managing our fund. We do not trade rapidly in an attempt to get rich quickly; rather, we arecontent to get rich slowly while investing conservatively, with a primary focus on capital preservation.

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As evidence of this, consider the four months in 2010 when the S&P 500 (with dividends reinvested)declined: January (-3.6%), May (-8.0%), June (-5.2), and August (-4.5%). During these months, theS&P 500 declined 19.7% in total

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but our fund was down a mere 1.3%. During the other eight monthswhen the market rose, our fund did okay, gaining 11.8%, but this trailed the market

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s 43.3% return.In summary, we earned a double-digit return while simultaneously being positioned very defensively,which is satisfactory to us.

Why We Missed the QE2 Rally

The fact that our house didn

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t burn down doesn

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t mean that we regret having bought insurance.However, with the benefit of hindsight (which is always 20/20), we bought too much insurance. As aresult, we went from crushing the market over the first eight months of 2010 to ending the year trailingit. The market is really quite remarkable in its ability to keep you humble. Just when you

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re feelingreally smart, it tends to come along and kick you in the shins, which is what happened to us during thelast four months of the year.As we discussed in recent monthly letters, o

ur underperformance wasn’t due to bad stock picking –

even

on the short side, we’d argue that

in most cases we made investments that have moved against ustemporarily, not permanently

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but rather due to completely misreading the short-term impact of the

Fed’s second round of quantitative easing (so

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called “QE2”). We interpreted the Fed’s move as

validating our assessment that the economy continued to suffer from many areas of weakness, mostnotably a terrible housing market and persistently high unemployment, and questioned whether QE2would achieve its objectives

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both of which made us cautious about the market. As a result, wecontinued to position our portfolio somewhat defensively, which turned out to be precisely wrong as themarket jumped 20.6% in the last four months of the year. The gains were driven by the frothiest, mostspeculative stocks, which are precisely the ones we tend to be short, so our profits on the long side wereoffset by losses on the short side such that we missed this big rally.The market surge was driven by two factors: fundamentals and froth. Regarding the former, whileunemployment remains a vexing problem, corporate earnings have been strong and the overall economyis showing some signs of life. Tha

t said, the data remains mixed and we still think the “muddlethrough” scenario we outline below remains the most likely outcome over the next 2

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7 years: “weak

GDP growth (1-3%), unemployment remaining high (7-9%), and continued government deficits. Underthis scenario, the stock market would likely compound at 3-6

%.”

A bigger driver of the market’s upward surge, we believe, is froth: the expectation (followed by theimplementation) of QE2 triggered a “don’t fight the Fed” burst of optimism across the mar

ket and, inparticular, a speculative orgy among the most popular momentum stocks, which ripped upwards,irrespective of valuation. It is nothing short of mind-boggling that a mere two years after utter panic andparalysis in the market, animal spirits have returned and reckless risk-taking is occurring in many areasof both the debt and equity markets. We think this will end badly and we will not participate. As

Buffett once wrote: “

We have no idea how long the excesses will last, nor do we know what will changethe attitudes of the government, lender and buyer that fuel them. But we know that the less prudencewith which others conduct their affairs, the greater the prudence with which we should conduct our ownaffairs.

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